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Chapter 4Figure It Out 16.1

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Suppose consumers value a high-quality used laptop computer at a price of $400, while they value a low-quality used laptop at $100. The supply of high-quality laptops is QH = PH – 100, while the supply of low-quality laptops is QL = 2PL – 50. Potential buyers cannot tell the difference between high-quality and low-quality laptops when purchasing one.

Assume that buyers believe there is a 50% probability that a used laptop will be of high quality. What would be the price that buyers are willing to pay for any used laptop?

Buyers should be willing to pay $

If buyers expect 50% of the used laptops available to be high quality (worth $400), and the other 50% low quality (worth $100), then the expected value of a laptop is equal to (0.5 × $400) + (0.5 × $100), or $250. Therefore buyers, who cannot distinguish between high-quality and low-quality laptops, should be willing to pay no more than $250 for a used laptop. For further review see section “The Lemons Problem and Adverse Selection”.
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      Suppose consumers value a high-quality used laptop computer at a price of $400, while they value a low-quality used laptop at $100. The supply of high-quality laptops is QH = PH – 100, while the supply of low-quality laptops is QL = 2PL – 50. Potential buyers cannot tell the difference between high-quality and low-quality laptops when purchasing one.

      If the price of a used laptop is $250, how many high-quality laptops will be offered for sale? How many low-quality laptops?

      high-quality laptops will be offered for sale.

      low-quality laptops will be offered for sale.

      Because the supply of high-quality laptops is QH = PH – 100, if the market price is $250, then 150 high-quality laptops will be offered for sale. Because the supply of low-quality laptops is QL = 2PL – 50, if the market price is $250, then 450 low-quality laptops will be offered for sale. For further review see section “Supply”.
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          Suppose consumers value a high-quality used laptop computer at a price of $400, while they value a low-quality used laptop at $100. The supply of high-quality laptops is QH = PH – 100, while the supply of low-quality laptops is QL = 2PL – 50. Potential buyers cannot tell the difference between high-quality and low-quality laptops when purchasing one.

          If the price of a used laptop is $250, what is the true probability of a buyer obtaining a high-quality laptop?

          		A.
          		B.
          		C.
          		D.
          Incorrect. At a price of $250, 150 high-quality laptops and 450 low-quality laptops are offered for sale, for a total of 600. Of those 600, 150, or 25%, are high-quality laptops. For further review see section “The Lemons Problem and Adverse Selection”.
          Correct. At a price of $250, 150 high-quality laptops and 450 low-quality laptops are offered for sale, for a total of 600. Of those 600, 150, or 25%, are high-quality laptops. For further review see section “The Lemons Problem and Adverse Selection”.
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              Suppose consumers value a high-quality used laptop computer at a price of $400, while they value a low-quality used laptop at $100. The supply of high-quality laptops is QH = PH – 100, while the supply of low-quality laptops is QL = 2PL – 50. Potential buyers cannot tell the difference between high-quality and low-quality laptops when purchasing one.

              If buyers believe there is a 50% probability of obtaining a high-quality laptop, laptops will sell for $250 and the true probability of obtaining a high-quality laptop will be 25%. What do you expect to happen as time passes?

              		A.
              		B.
              		C.
              		D.
              Incorrect. When buyers learn that they have overestimated the probability of obtaining a high-quality laptop, they will revise their probability downward. This will reduce their willingness to pay for laptops of unknown quality, and the price of used laptops will fall. As the price falls, fewer high-quality laptops will be offered for sale, further reducing the probability of obtaining a high-quality laptop. For further review see section “The Lemons Problem and Adverse Selection”.
              Correct! When buyers learn that they have overestimated the probability of obtaining a high-quality laptop, they will revise their probability downward. This will reduce their willingness to pay for laptops of unknown quality, and the price of used laptops will fall. As the price falls, fewer high-quality laptops will be offered for sale, further reducing the probability of obtaining a high-quality laptop. For further review see section “The Lemons Problem and Adverse Selection”.
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